Daily Development for Wednesday, April 2, 2003
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC
School of Law
Of Counsel: Blackwell Sanders
Peper Martin
Kansas City, Missouri
dirt@umkc.edu
LEASES; ASSIGNMENTS AND SUBLEASES; LIABILITY OF
ASSIGNEE: Where lender has prior assignment of lease for
security,
but later, after bankruptcy of
tenant, acquires the tenant's leasehold estate
in a bankruptcy auction, the controlling relationship is that established
by
the assignment in bankruptcy, and the terms
of the prior assignment for
security have no
impact on the question of lender/assignee's obligation to
pay rent.
Cherry v. First State Bank, 2003 WL 288467 No.
E2002-0081-COA-
R#-CV (Tenn App.
12/12/02)
Tenant earlier had executed a leasehold mortgage and an
assignment for
security of the lease in favor
of Lender. The assignment for security
provided that Lender would not be liable for the rent or any
other
obligation of Borrower under the Lease
"so long as the Bank shall not
have exercised
its option [of taking over the leased premises pursuant to
written notice.]"
Later, Tenant declared bankruptcy. At a "sale free and
clear of liens" in
the bankruptcy proceeding,
the auctioneer offered the tenant's leasehold
estate for sale at auction, and also offered at auction adjacent
property
that the tenant owned in fee.
The bid for the two items offered together
exceeded the sum of the bids for each of the items offered separately
and
the lease and fee together were hammered
off to the successful bidder,
which was, lo and
behold, Lender!
Lender paid rent under the lease for a while, and then
stopped, running
up a bill that eventually
totaled over $100,000 (plus attorney's fees.)
When Landlord came looking for the rent, Lender pointed to
the
language of the original assignment for
security and argued that it had
never given the
Borrower written notice of exercising its option to take
over the leased premises, and hence was not liable for any
of the
obligations under the lease.
Lender attempted to explain this apparently absurd position
by claiming
that, at the time of the bankruptcy
auction, it had bid for the fee and
leasehold
estate together "to protect its position" and that it had not
intended to take a new and different assignment of lease,
and refused to
execute an assignment when
tendered by the debtor, who was acting as
Debtor in Possession in the bankruptcy. The court notes that
an
assignment later was entered into between
the parties.
Lender made payments under the lease for the period it did,
Lender
claimed, "for the purposes of preserving
its rights under the lease" -
apparently this
refers to the earlier assignment for security. Lender never
took possession, never announced that it was asserting
rights under the
earlier lease, and therefore
did not deem itself bound by the lease
obligations. They note that Landlords knew of and consented to
the
original assignment of lease for
security.
The trial court, not surprisingly, granted summary judgment
for
Landlord. It is surprising, of
course, that Lender still hadn't figured
things
out, and appealed. But the Tennessee Court of Appeals properly
slammed Lender again. By bidding at the bankruptcy
auction, Lender
had taken a new assignment
unrelated to the first assignment, and was
bound by its privity of estate to pay the rents.
Comment 1: In fairness to Lender, there is a
suggestion in the opinion of
a subtext
involving shadowing evidence of various special agreements
and discussions among the parties that they agreed, for one
reason or
another, would not be part of the
evidence in this case. So Lender may
have
felt that it had right and justice on its side, even though it
clearly
didn't have the law, at least based
upon what was presented to the court.
Otherwise, the case is such a "slam dunk" that it is hard to
understand
why Lender would pay for an appeal,
which cost Lender not only its own
attorney's
fees, but those of the landlord as well.
Comment 2: The editor, in fact, has selected this case not
for the distinct
legal point discussed above,
but to raise the question: What's up with
these
assignments of tenant's interest for security? The editor has
seen
them before, and, from talking to an
experienced landlord/tenant lawyer,
understands
that in fact they are used quite commonly as security devices
when tenants borrow.
There is absolutely no question in the editor's mind that
these
assignments for security are invalid as
assignments. They are clogs on
the equity
of redemption, analogous to an absolute deed intended as a
mortgage, and any decent lawyer ought to be able to
demonstrate to a
court that they should be
converted into an equitable mortgage, with right
of redemption, either before or after they are "activated" by the
lender.
Note that we're talking about an assignment of the tenant's
possessor
interest under the lease - which is a
real estate interest almost
everywhere.
We're not talking about an assignment of the landlord's
interest. The landlord's interest in a lease may be a
"chose" which can
be assigned for
security. Even in the rare jurisdiction (if one exists)
where the tenant's interest is a personal property
interest, one would
assume that Article Nine
would operate to control some of the lender's
rights in any event. The assignment would not always be
absolute.
It is true that the consequence to the lender of taking such
an assignment
is not so dramatic if the worst
thing that can happen is that the
assignment
gets "flipped into an equitable mortgage." But it's still not
a
good idea if the lender is in a state like
Missouri where a legal deed of
trust covering
the leasehold could be foreclosed in 21 days, but an
equitable mortgage would require a court action stretching out
six
months or more in an urban
area.
There's also the problem of lawyers writing opinions
approving the
enforceability of the lender's
remedy under these things and title insurers
insuring their validity. The editor doesn't know that these things
happen,
but is led to believe that they must,
in light of the frequency that these
instruments apparently appear.
Comment 3: Even Milton Friedman in the revered Friedman on
Leasing
doesn't really make the point that
assignments for security are invalid.
He simply
reports, in footnote 2 on page 464, a number of cases in which
courts have construed issues concerning assignments for
security. A
quick look at these cases
indicates that the lawyers did not apparently
raise the equitable mortgage argument, and the courts didn't pick it
up.
Be warned. It's there.
Readers are encouraged to respond to or criticize this posting.
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